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Small-Cap Merger Arbitrage

Carmike Cinemas (NASDAQ: CKEC) is a small-cap theatre operator, with a $740 million market cap. It’s got a buyout offer on the table from AMC Entertainment (NYSE: AMC), which is offering $30 a share in cash.

The deal is expected to close before 2017 and would be accretive to free cash flow next year 2017. But with Carmike trading right at $30 a share, the market could be betting on a higher bid. As are some hedge fund investors.

AMC is the best buyer for AMC, but the key will be getting them to pay more. Even with the buyout offer, shares of Carmike are flat over the last year. And the 52-week high is closer to $35 a share.

Activist investor Oasis Management started putting pressure on Carmike last year. It owns 5% and has pushed for a dividend or buyback from Carmike. They certainly feel the $30 a share offer undervalues Carmike, but is there enough collective interest to get AMC to the negotiating table?

Getting A Higher Bid

Mittleman Brothers has already spoken out against the deal. It owns 7.1% of the company and has been an owner since 2007. The fund changed its stake from passive to activist this week and now plans to vote against the buyout.

AMC CEO Adam Aron has even held a conference call to talk about the bargain price he got Carmike for.

This comes as the deal undervalues Carmike relative to other theaters. It’s managed to post better earnings growth relative to notable peer Regal Cinemas. The Carmike buyout is roughly 7.5x to 8x EV/EBITDA, while Regal trades at over 9x.

At a similar multiple, Carmike should trade at $38 a share. Mittleman believes fair value for Carmike is around $40 a share - at 9.5x. A premium valuation for the complete change of control, versus a stock swap deal. It says it won’t accept an offer lower than $40 a share in cash, or $35 a share in AMC stock.

Part of the reason that AMC won’t do a stock swap is that Carmike shares are too cheap. It’s unwilling to issue shares at 8x EV/EBITDA, despite the fact that it’ll be almost immediately accretive to cash flow and cost synergies. The joint company is expected to save $35 million - which puts the pro forma AMC buyout multiple down to 6.5x.

But Mittleman points out that AMC gains $250 million worth of founder shares in National CineMedia and puts the cost of the Carmike acquisition to just 5x EBITDA. Lest we forget AMC ha NOLs that it will use to shield Carmike’s net income from taxes for years.

The merger has no go-shop provision or auction process. And Mittleman notes that there’s been no private market transactions in major movie theater companies (EV $1B+) in the developed world at such a low valuation (8x EBITDA or less). The most recent transaction in a $1B+ enterprise value movie theater company was the London-based Vue Entertainment buyout in September 2013 for 8.5x EBITDA.

Mittleman is reaching out to other shareholders, hoping to garner support for the plan to block the merger. The shareholder base has been turned over a lot over the last few days, but it’ll be interesting to see if a bidding war along the lines of Pep Boys and Carl Icahn breaks out over Carmike.

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